Financial Analysis of H&m
Profitability
A ratio analysis and a cash flow analysis were used to assess the performance of H&M and efficiency of the company’s operations and investment policies. For this reason, a time-series comparison of 2009 and 2010 data of the most important ratios together with a cross-sectional comparison with its closest peer Inditex has been performed (Appendix 11).We employ return on equity (ROE) as an indicator to evaluate H&M’s overall profitability, since it captures how well managers are employing the funds invested by the shareholders to generate returns. The alternative decomposition of ROE is preferred over the traditional one because it provides a better identification of the key profitability drivers by separating operating and financing activities. Overall ROE for H&M increased from 44.5% (2009) to 46.5% (2010) with an increase in operating ROA as main driver. The identified closest peer Inditex achieved the same growth reaching ROE of 32.9% in 2010 and although Inditex achieved a higher operating ROA, their business suffered from negative financial leverage gains which offset its operating advantage. According to Bloomberg data, the non-adjusted industry average ROE is 17.8% (excluding outliers) and the non-adjusted industry median is 15.4%. This shows that both companies significantly outperform the industry which is an indication of a superior business model.
Looking at the financing policy on ROE, a small decrease in leverage has decreased the tax benefits of debt which in turn is partially offset by an increasing spread due to higher operational profitability.
Operating Management
A slight increase in the NOPAT margin for H&M was observed in 2010. Inditex is still under performing with regard to H&M but at the same time diminishing the gap through a higher growth. The EBITDA margins exhibit the same trends. To get a better understanding of the performance of H&M, we looked at the common-sized income statements. The improvement in NOPAT was driven mainly by a decrease in cost of materials and personnel expense. The former can be explained by an increase in retail space even in mature markets which H&M could penetrate through lower freight costs and the exploitation of spare capacities. A possible reason for the decrease in personnel expenses is the growing share of online sales while Inditex benefitted from a larger decrease in procurement costs due to a superior cost control policy. Tax and interest expenses for H&M incurred only marginal changes which indicate relatively stable financing conditions.
Investment Management
A difference between ROA and operating ROA (far larger operating ROA) is driven by asset turnover vs. net operating asset turnover. Because of the nature of the apparel retail business, the company has both, large cash holdings and significant current liabilities (mostly accounts payable and accrued expenses and other classified income). Net operating asset turnover for H&M has increased slightly (1.47) which indicates the higher efficient usage of company’s assets. Here, main competitor Inditex showed a clear advantage in this measure (2.02). Furthermore, its improvement was larger in comparison to H&M. In 2010, H&M experienced a decrease in both, trade receivables turnover and inventories turnover since they seemingly managed to roll these over to the suppliers and evenly decreased their trade payables turnover from 10.61 to 10.14. Nevertheless, the fundamental driver of the large increase in operating working capital turnover is the tax policy adopted by the company(Increase of current tax liabilities by 1865 million SEK in 2010). Operating working capital turnover is negative for Inditex due to significantly lower payable trade turnover. We detected a slight increase in efficiency of non-current assets (almost entirely consisting of PP&E) usage due to the fact that online sales become more prevalent in H&M´s business model. For Inditex the same trend can be observed whose improvement is again slightly larger.
Financial Management
H&M´s liquidity ratios deteriorated slightly in 2010. However, the company maintains a comfortable buffer against short-term liquidity risk and outperforms its main competitor Inditexin these fields. In 2010, H&M decreased its financial leverage (post adjustments) by 10% to55%. Prior to our implemented financial lease adjustment, the company had virtually no leverage (Debt-to-capital 0.4% in 2010) while after accounting for the rental agreements as financial lease liabilities, this dramatically changed (Debt-to-capital 44.5% in 2010). In terms of interest coverage ratios, H&M and its competitor Inditex are both situated in an obviously safe position.
Sustainable growth rate
To assess the dividend policy implemented by H&M we looked at the sustainable growth rate of the company. A decrease in the dividend payout rate paired with the already mentioned increase in ROE led to a boost in the sustainable growth rate in 2010 to 18.7% which exceeds the 12%CAGR (sales) of H&M over the periods 2006 – 2010. The non-adjusted sustainable growth rate of the company is 12.3% which is in line with the actual achieved performance. This discrepancy might represent another rationale behind the omission of the rental premises from balance sheet items: investors might demand a higher dividend payout. Due to a lower payout rate, Inditex achieved a higher sustainable growth rate despite its lower ROE.